As a trustee or committee member for your organization’s employee benefit plan, you have the fiduciary responsibility to choose the most beneficial investment options that have a good potential of return for the investor (your employees). Recognizing this responsibility, the U.S. Department of Labor (DOL) recently announced that it discourages trustees from choosing environmental, social, and governance (ESG) investment options within employee benefit plans. An ESG can be an individual stock, mutual fund, or index that’s specifically identified towards ESG companies (i.e. all of the companies under the fund would support the ESG movement, such as a company that makes paper straws as an alternative to plastic). Due to recent trends seen in the ESG movement, this Final Rule seeks to give clear regulatory guidelines for employee benefit program trustees surrounding investments in this sector. We’ve taken a look at why the DOL is deterring such objectives and break down the most important factors of the recent ruling.
What is the Final Rule?
To further protect American retirement investments, the DOL’s Final Rule was issued under the Employee Retirement Income Security Act of 1974 (ERISA) and discourages trustees from considering investments that support non-financial objectives, such as environmental, social, corporate governance, or other similar ESG objectives. These amendments aim to clarify and simplify trustees’ investment decision making processes when considering ESG initiatives.
Breaking it Down
We’ve compiled some of the most important factors of this Final Rule that trustees should pay critical attention to when engaging in employee benefit financial planning. According to the DOL:
- Trustees should stay away from investment opportunities that promote non-financial objectives (such as aiding environmental, social, and public policy goals).
- The recent influx of these ESG investment considerations has raised important questions about deficiencies in the prudence and loyalty analysis by some people investing in the ESG market. The new rule seeks to clarify these questions, as its last few iterations of similar guidance created slight confusion about these investment issues.
- The new amendments require trustees to select investment options based on “pecuniary factors,” meaning any factor that the responsible trustee determines will have a high possibility of having a material effect on risk or return of an investment based on appropriate investment horizons consistent with the plan’s objectives and funding policy.
- This requires trustees to evaluate all investments based solely on pecuniary factors, and heavily encourages ERISA financial fiduciaries to refrain from making investment decisions based on non-pecuniary factors.
- The DOL expects this rule will eventually result in higher returns by requiring trustees to make investment decisions based on financial factors.
- If the trustee chooses to offer an investment option that doesn’t definitively provide material benefits, the rule requires that the trustee documents:
- Why pecuniary factors weren’t sufficient to select the investment
- How the selected investment compares to the alternative investments with regard to composition, liquidity, and returns
- How the non-pecuniary factors considered in making the investment decision are consistent with the interests of the participants in their retirement income or financial benefits under the plan
This further deters ERISA fiduciaries from making investment decisions based on non-pecuniary factors.
- This rule states that trustees may not subordinate the interests of participants in their retirement income or financial benefits under the plan to other objectives. This prohibits fiduciaries from sacrificing investment returns or assuming additional investment risks to pursue non-pecuniary objectives.
One of the main objectives of the DOL is to protect the retirement savings of Americans. By ensuring that employee benefit plan committees and trustees are focused solely on the fiscal initiatives of plan members, this rule helps trustees offer better options for more secure, profitable retirement benefits. ERISA financial fiduciaries should consider these amendments and evaluate whether their current investment policies align with the obligations set in the Final Rule. This rule will take effect on January 12, 2021 and will apply prospectively to investment decisions made after the effective date.